From the April, 2001 Newsletter
Overview
Federal and provincial capital taxes are a tax on the capital of a corporation. Federal Large Corporation capital tax (“LCT”) to the extent otherwise assessable may be reduced federal corporate surtax payable. LCT is not deductible in computing income for income tax purposes. Therefore, LCT is an absolute incidence of tax.
Provincial corporation capital tax is generally held to be deductible in computing income for income tax purposes. The provincial corporation capital tax (“MBCT”) incurred is tax deductible resulting in only one-half of the tax as an absolute incidence of tax.
Notwithstanding the above capital taxes represent a true cost of capital. The magnitude of this cost relative to interest rates being charged currently for financing and in light of the current inflation rate represents a significant cost of capital to corporations subject to these two forms of taxation. Additionally, the taxes arise regardless of income in the year or the ability to pay.
For MBCT purposes, the MBCT tax rate is .3% of taxable capital once taxable capital of the corporation plus all associated corporations exceeds $5 million. An incremental surcharge of .2% raising the tax rate to .5% applies on taxable capital exceeding $10 million.
The LCT is charged at .225% on taxable capital in excess of $10 million of all associated companies.
Paid-Up Capital
Paid-up capital for capital tax purposes generally comprises paid-up capital stock, surplus accounts, certain reserves, loans and advances to the corporation. Deductions in computing paid-up capital for capital tax purposes include deficits, certain negative reserves and investment allowances. Investment allowances represent certain investments in other corporations, government bonds and cross border amounts due from related non-resident corporations.
The capital tax base calculation is inconsistent between federal and provincial tax base calculations. Various items included/excluded provincially may be included/excluded federally.
Once the paid-up capital is computed the threshold deductions as discussed above are applied in determining taxable paid-up capital. It is taxable paid-up capital against which the capital tax rate is applied and taxes estimated.
Tax Avoidance Strategies
LCT and MBCT avoidance strategies in principle include reducing capital, increasing investment allowance, multiplying access to the capital deduction, corporate restructuring, inter-provincial shifting of revenues, and certain other hybrid tax strategies. Below is a general discussion of some of the more common items to consider in trying to minimize MBCT or
LCT.
Reducing Capital
Reducing capital can be undertaken in a number of ways. These include something as simple as choosing a fiscal year-end for tax purposes that coincides with the time when the capital requirements of the firm are the least. This would include for example in the case of a seasonal corporation the time in which the company is cash flush. At that time, the corporation can pay down its debt thereby reducing capital.
A review of balance sheet assets ought to be undertaken near year-end to establish whether certain investments otherwise ineligible for the investment allowance treatment can be liquidated freeing up cash for paying down debt otherwise constituting a component of paid-up capital. All too often we see related companies with inter-company balances that could easily be offset and/or paid out in order to reduce paid up capital or to establish eligible investments for investment allowance purposes.
Another tactic, of course, is to extend trade accounts payable, a current liability not necessarily a component of paid-up capital, in order to free up cash and funds to reduce debt obligations otherwise comprising paid-up capital.
One final tactic in reducing capital would be to maximize deductible and discretionary deductions for financial statement purposes in order to reduce paid-up capital, that is to suppress the increase to retained earnings in the year.
There are a variety of ways beyond those discussed above where the corporate taxpayer can contemplate increasing eligible investments, increased investment allowance or free up cash or working capital to reduce capital otherwise comprising a component of paid-up capital. One has to be careful though with timing in that the federal LCT versus the MBCT sometimes include different rules regarding the period within which certain items have to be either invested to qualify as investment allowance or how long outstanding a liability can be before it is includible in the capital tax base.
Increasing Investment Allowance
Investment allowance represents a deduction in computing both MBCT and LCT. Some of the more common strategies one can adopt in order to increase investment allowance include focusing on collecting outstanding accounts receivable that are not otherwise eligible for investment allowance. These funds can then be invested in eligible investments or be used as proceeds to pay down debt otherwise comprising a component of paid-up capital. Certain financial institutions and other corporations do offer certain hybrid investment vehicles which can be invested in temporarily to qualify as investment allowance for these purposes.
The firm can purchase eligible investments such as bonds, debentures and shares of other corporations other than a financial institution thereby establishing investment allowance eligible investments.
Another tactic includes investing in foreign corporations which are not financial institutions. These foreign corporations, unless they carry on business in Canada through a Canadian permanent establishment, will not in of themselves be subject to LCT or
MBCT.
Capital Deduction
The capital deduction is the amount that is the base threshold over which MBCT and LCT become otherwise eligible. These capital deductions must be shared among associated corporations.
One tactic that may be employed is to disassociate corporations within the corporate group in order to multiply access to the capital deduction. This can be done through a variety of strategies involving corporate reorganizations and establishing hybrid ownership vehicles.
Other Considerations
Many business enterprises use a variety of corporations to hold and operate assets for various business reasons. These reasons include minimizing business risks, isolating various risks from other assets within the corporate group, special purpose corporations used to separate various business income types and asset types, in order to direct and redirect accretion in value among various generations of individuals within the corporate ownership. Often corporate reorganizations such as amalgamations, and wind-ups can multiply or streamline taxable paid-up capital.
Additionally, if a corporate group is undergoing a series of corporate restructurings, timing of these amalgamations and wind-ups can represent significant savings in MBCT and LCT. Therefore, any corporate restructuring should consider the MBCT and LCT implications in its deliberations and due diligence process.
The shifting of revenues and salaries to a province with a lower capital tax rate or no capital tax is another tactic to reduce the capital tax liability of a corporation. Therefore, to the extent one can engineer shifts of revenues and salaries to low tax rate or no tax rate jurisdictions MBCT savings may be achievable.
For more information on these or other tax strategies, please contact:
Henri Dupont 957-2278 hdupont@kpmg.ca or
Derek Dalsin 957-2214 ddalsin@kpmg.ca